International legislation is starting to catch up on crypto tokens and currency trading. Although new laws are being created much of the debate depends on deciding what these new entities should be legally defined as and how existing legislation will apply to them.
In the USA crypto traders are increasingly coming under the remit of the Securities and Exchange Commission (SEC). A key problem is in defining if crypto is some kind of security (such as bond) or goods (such as wheat or gold). USA legislation uses the ‘Howey Test’: Something is a security if it meets all 4 of these criteria:
- Money is invested.
- There is an expectation the investor will earn a profit.
- The investment is in a common enterprise.
- Profits are generated via the efforts of others.
The original Howey case in 1946 is an interesting example of how activities are defined by law. Investors would buy land in Florida planted with groves of citrus trees. They would then lease the land to the WJ Howey Company who would farm the trees and pay a portion of the profits to the investors. Land is form of good that can be bought and sold. The US Supreme Court ruled that the overall Howey strategy was an investment not a sale of goods as the buyers were primarily being offered an investment in the expectation of making a profit. Laws on securities and investments are in place to protect the buyer from outright scams and to put controls in place to let the potential investor understand any potential risks.
The classification of any crypto enterprise will need to be on a case by case basis. In 2022 Bitcoin was expressly defined as a commodity (not an investment) by the SEC. Among the possible candidates for crypto investments would be ICOs (initial coin offerings) where investments are solicited for crypto currencies that are yet to exist. The investors being attracted by the potential of an increase in coin value on launch. As of June 2023 SEC lawsuits have identified 68 crypto enterprises as securities, these are not necessarily all ICOs.
The SEC is charging Coinbase with operating as an unregistered securities dealer within the USA. Coinbase’s prime business model is as a platform to buy and sell cryptocurrency. In this case the SEC alleges that Coinbase is acting as a broker but more importantly is using the funds it handles to manage ‘proof of state’ transactions on various blockchains and sharing profits with customers. Coinbase have claimed that the existing rules were unclear whereas the SEC stance is that Coinbase was aware of the rules and cannot choose to ignore them.
Although these are USA based actions they will have implications on other markets where similar decisions will need to be made or have been made by local legislations